Innovation Market Theory and Practice: An Analysis and Proposal for Reform

Kent Bernard, May 20, 2011

Encouraging and/or preserving innovation in mergers and acquisitions have been critical factors in modern antitrust analysis. These aims have been justification for the breakup of proposed research programs targeting diseases as serious as HIV/AIDS and cancer. The rationale given is always to protect competition and enhance the benefits to consumers.

Lawyers and economists justify intervention in mergers based on predictions of what will or might happen many years down the road in scientific research programs. They base those predictions on various theories and assumptions of how companies behave. But an examination of the actual drivers in the research based pharmaceutical industry, such as the time factor of revenue destruction and the resulting continuing need for new products, along with a review of what happened in key cases after the agencies acted, reveals that those underlying assumptions may well have been unfounded.

This factual consideration of how business actually behaves has been missing from the analysis. This article looks at the leading approaches to “innovation markets.” It then reviews the key cases in which the theory has been applied, and looks to see what actually happened after the case files were closed. In other words, did the intervention do any good, and/or did the lack of intervention do any harm?

The results of that inquiry strongly suggest that not only was the intervention not beneficial, it may have dampened innovation by reducing the potential reward while ignoring the risks that any innovator is being asked to run. Innovation market theory arose out of a concern that mergers were reducing innovative capacity. The regular tools of analysis failed to provide a remedy for this sort of highly speculative harm, so the agencies stretched the concept of innovation markets to allow them to act under it. However, the analysis here shows that the perceived risk was based on a misapprehension about how companies actually behave and the nature of innovation itself. Once that is understood, the need to stretch the concept of innovation markets goes away.

This article also proposes an alternative approach, grounded in traditional antitrust but based on market reality rather than theory. When this approach is applied to the facts of the cases, it allows intervention when needed while avoiding speculative interference with scientific and business pursuits.